How Will Rising Rates Impact Affordability?

Analysts have predicted that mortgage rates, which are now at their highest level in a year and a half, will result in a shift from a refinance-driven originations market to one that is more purchase loan-oriented.

A recent analysis from Black Knight Financial Services shows evidence that the shift is taking place, reporting a decline of approximately 60 percent (from 8.3 million down to 3.3 million) in the number of candidates who would benefit and have the incentive to refinance in the last two months. In addition, CoreLogic Chief Economist Frank Nothaft said the market can expect “a drop in refinance originations in 2017,” due to the higher rates, and “This drop will be at least partly offset by higher purchase-money volume and second liens, either HELOCs on single-family or mezzanine debt on multifamily.”

Meanwhile, purchase loans have not suffered, according to Zillow Mortgage Group. The rising mortgage rates have not deterred buyers from making purchase loans, with those buyers perhaps feeling a sense of urgency to move before rates increase further, according to Zillow. The Federal Open Market Committee is expected to raise the federal funds target rate by 25 basis points on Wednesday, December 14—which influences the mortgage bond market, which could push mortgage rates higher.

“While those looking to buy a home are understandably concerned about the path of rates ahead, it's important to remember that borrowing costs remain exceptionally low by historical standards,” said Erin Lantz, vice president of mortgages for Zillow Group. “Rising rates may impact the location or size of the home they hope to purchase, but buyers that are fully committed to buying a home are unlikely to be swayed by the FOMC's decision to raise rates.”

Zillow Group found in its Report on Consumer Housing Trends that the decision to buy a home is more often tied to a consumer’s financial well-being rather than the current level of interest rates, and that a “life event” such as a job change, promotion, or change in the number of people living in the household often precedes the purchase of a home.

A Fed rate hike, even if the result is higher mortgage rates, will likely have a minimal impact on affordability, according to Zillow Group. An increase in mortgage rates from 4 percent to 4.25 percent would result in a monthly mortgage payment only $22 higher on a median-priced home valued at $191,200, Zillow estimates. That same rate increase would result in a higher monthly payment of $25 or less in 18 of the country’s largest 35 metros. An increase in rates would have the biggest impact in markets where affordability is already an issue, such as Los Angeles, San Francisco, or San Jose, Zillow said.

The higher mortgage rates will give buyers with all-cash offers an advantage in more competitive markets where entry-level inventory is tight, according to Zillow.

“It remains to be seen whether a more aggressive path of rate hikes will be implemented in 2017,” Lantz said. “Should economic indicators continue to improve and the pace of policy normalization picks up, we will eventually see the end of incredibly low mortgage rates and corresponding high affordability.”